WHY CAN'T CHINA SEAL THE DEALS?

Thursday, September 5, 2013

The sale of AIG's aviation leasing business to a Chinese group is close to collapse, signalling the implosion of yet another Chinese bid to control such assets — the third in just a few years. When Chinese groups show up at auctions these days, the response is more scepticism than celebration.

In this case, the Chinese buying group fell apart. In other cases, involving potential purchasers ranging from obscure groups to well-known banks, either approvals or financing or the prevailing fear of overpaying were factors.

China Development Bank submitted the highest bid for the aviation leasing assets of Royal Bank of Scotland by a margin of $US240 million ($A268.3 million), despite the bank believing it had no chance of getting approval for the deal. A Chinese group bidding for Hawker Beechcraft could not come up with the financing and lobbied vehemently (albeit unsuccessfully) for the return of its $US50 million deposit. Bank of China submitted a lowball bid not once, but twice for an Indonesian bank that Temasek was selling, which went ultimately to Maybank).

Investment bankers who once boasted to clients in the west of their contacts among potential Chinese buyers of assets and companies are no longer quite as confident in the strength of that pitch.

It was not supposed to be like this. China has massive amounts of money and a hunger for everything from the natural resources it lacks to leading-edge technology. If it is to transform itself into a consumer-led economy, it needs to upgrade manufacturing, its brands and design. The degree of competition in China is intense, so even where overcapacity is not an issue, profit margins are often razor thin, making overseas markets far more attractive by comparison.

Yet it is clear that China is not quite ready for primetime on the mergers and acquisitions front. Just having money and ambition, it seems, is not quite enough. One adviser retained to help a Chinese bank acquire a Russian bank (for reasons that remain obscure) asked the hopeful buyer if there was anyone at the bank who actually spoke Russian, and was told there was not. So, even when approvals and financing are forthcoming, more intangible, cultural factors remain a problem — language being only one of them.

Moreover, there are few domestic mergers and acquisitions, so most companies have little practical experience of how deals get done. In addition, with the exception of a few technology companies, Chinese companies still lack internal specialists with titles such as 'chief strategic officer' to think about these matters.

In many cases, the Chinese encounter hostility and xenophobia when they do venture abroad. Consider the contention around Shuanghui International's $4.7bn acquisition of Smithfield Foods, which has become hostage to pork-barrel politics in the United States.

Of course, there are sectors where the Chinese have successfully closed deals. The two top sectors —oil and gas and mining — account for more than half of all deals since 2000 and involved nearly $US200 billion out of a total $US368 billion in outbound transactions, according to data from Dealogic. The Chinese government was behind virtually all these transactions, which were led by state-owned enterprises with the cheap financing of the policy banks such as China Development Bank that have access to the balance sheet of China itself.

So far, most successful acquirers have been state-owned companies with the blessing of the government.

Looking ahead, the next wave is likely to involve more privately owned companies doing smaller deals, particularly technology companies that are intrinsically more global. Such deals are likely to be targeted more at Europe (particularly Germany) than the United States, where the only thing equal to the paranoia of the US about China is China's paranoia about the United States. But that should not restrict capital outflows from China.

Many people involved on both sides of the border believe the next big thing will be real estate, as Chinese developers and institutional investors look abroad, especially to the United States.

Funding and permission are easier to obtain in China and often are a simple formality in the United States.

"Mergers and acquisitions are the hardest outbound capital to succeed," says Howard Chao, a lawyer with O'Melveny & Myers on the west coast. "You have to move fast and have everything in order and get approvals. It is much easier to buy big buildings. You can move money quickly, and there are usually no political issues. Chinese portfolio flows will also be big. Mergers will take a smaller part of the capital flowing out of China."

There is another (unvoiced) reason real estate deals are attractive. With enough money, Chinese investors can get temporary green cards. Chinese people are increasingly following their money out of China.